Tuesday, October 28, 2008

This morning Volkswagen (VOW) was worth more than Exxon Mobile (XOM) as common shares rocketed up as much as 93% on a short squeeze.

Prosche, in an attempt to take over the carmaker has engineered a shortage of common shares by gobbling up as much as 75% of the company via options. The counter parties to these options went long the actual stock to hedge their exposure, leaving the shorts scrambling for shares to buy back.

Volkswagen rose as much as 485.01 euros, or 93 percent, to 1,005.01 euros and was up 55 percent as of 11:10 a.m. in Frankfurt trading. Wolfsburg, Germany-based Volkswagen has risen more than fivefold this year and at its intraday peak was valued at 296 billion euros ($370 billion), more than Exxon Mobil Corp.'s $343 billion market value at yesterday's closing price in New York, according to data compiled by Bloomberg.

Porsche, the maker of the 911 sports car, has accumulated Volkswagen shares since 2005 in an effort to protect ties to its largest supplier. Porsche said Oct. 26 that it aims to increase its holding from 42.6 percent. That prompted some short-sellers to buy from a shrinking pool of stock to end their bets. BaFin, Germany's financial-market regulator, said today that it's monitoring trading in Volkswagen shares following the gains.

“One of the biggest risks with the herd mentality approach to shorting is that a lot of money can be made on the outset,” said Ed Oliver, a senior business consultant at Spitalfields Advisors, a London-based firm specializing in securities lending. “But you can end up losing the whole of it when you try to close the position. There's no limit.”

Stock On Loan

Volkswagen's surge came as 23 of the 29 other stocks in the country's benchmark DAX Index fell on investor concern that a slowdown in the global economy is accelerating. About 12.9 percent of Volkswagen's common stock was on loan as of Oct. 23, mostly for short sales, the highest proportion of any company on the DAX, according to London-based Data Explorers.

Stuttgart, Germany-based Porsche added to an earlier 35 percent stake and said two days ago that it holds options for another 31.5 percent.

“Porsche heads for a domination agreement and triggers a short-squeeze,” Horst Schneider, an HSBC Holdings Plc analyst in Dusseldorf, Germany, wrote in a report yesterday, in which he upgraded Volkswagen's common shares to “neutral” from “underweight.” The stock “will be more driven by covering of short positions rather than by fundamental valuations.”

Carmakers worldwide are struggling with plunging sales as credit markets seize up and economies contract, deterring consumers from making large purchases. U.S. industry-wide auto sales fell 27 percent in September, the steepest monthly slide since 1991, while nine-month deliveries in Europe declined 4.4 percent as September sales dropped 8.2 percent.

Ratings Cut

PSA Peugeot Citroen, Europe's second-biggest carmaker, and smaller French competitor Renault SA both had their credit ratings downgraded by Moody's Investors Service because of the risk that car markets won't recover next year. Standard & Poor's said it may cut the credit rating of Fiat SpA, Italy's largest carmaker, to less than investment grade.

Until yesterday, when the stock more than doubled, Volkswagen's biggest gain in almost two decades was a 27 percent jump on Sept. 18. People familiar with securities lending said at the time that the collapse of Lehman Brothers Holdings Inc. caused the increase by triggering recalls of borrowings. The stock fell 23 percent on Oct. 20, the biggest drop also in almost two decades, as short-sellers predicted the price would decline once Porsche gains control.

Largest Shareholders

There may be little ordinary stock freely trading in Volkswagen because most of the shares are owned by Porsche, the German state of Lower Saxony and the banks that underwrote Porsche's options, Adam Jonas, a London-based analyst at Morgan Stanley, wrote in a research report yesterday. Lower Saxony is Volkswagen's second-biggest owner with a 20.1 percent stake.

Index-tracking funds also hold stakes in Volkswagen, now the DAX's most-weighted stock, and must retain the holdings as long as the carmaker remains a member.

Deutsche Boerse AG, the operator of Germany's main stock markets, said Volkswagen will remain in the DAX unless the carmaker announces the freely traded stock no longer meets requirements.

“We're applying our regulatory framework and, as long as Volkswagen's free float is above 5 percent, the index won't be changed,” said Torsten Baar, a spokesman for Frankfurt-based Deutsche Boerse.

BaFin is analyzing trading in Volkswagen stock, though it hasn't opened a formal inquiry into whether there's any manipulation and “pure cash-settled options do not require disclosure” under the country's laws, said Anja Engelland, a spokeswoman for the Bonn-based agency. Results from any analysis are unlikely this week, she added.

Porsche's Intent

Until Oct. 26, Porsche had said it was aiming only for a stake exceeding 50 percent, and Chief Executive Officer Wendelin Wiedeking said at the Paris Motor Show early this month that a stake of as much as 75 percent would be “not realistic” because of market turmoil.

Short sales have largely been undertaken by investors betting on a decline in Volkswagen's common stock, which hold voting rights, or its underperformance relative to the preferred shares, which carry no votes, according to analysts.

The common shares, which outnumber the preferred equity almost three to one, are the only gainers this year on either the DAX or the nine-member Bloomberg Europe Autos Index. In contrast, Volkswagen's preferred stock has dropped 62 percent, including a 14 percent decline yesterday, to 37.89 euros.

“Volkswagen has been one of the greatest shorts of hedge funds, and it's been an absolute, absolute disaster,” Emmanuel Roman, co-chief executive officer of GLG Partners Inc., said at a conference in London on Oct. 23. “It's been very painful.” GLG didn't participate in short-selling trading of the carmaker's common shares, he said.”

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Disclaimer

The Financial Ninja is a collection of my thoughts and opinions about current economic and market conditions. These are not buy and sell recommendations. Use your head and do your own research. This is a forum to stimulate discussion and debate.

About Me

I started trading during the tech bubble when I was still in high school. My trading has financed my education and I have since completed a BA in Economics and an MBA with a concentration in Finance. I have worked as both a proprietary equity and fixed income derivatives trader.